It could have been worse. That is the message emanating from leading commentators on the Indian economy. This is attributable to the Reserve Bank of India’s conservative policies that have largely staved off a deeper crisis within the country.
Today’s Business Standard carries a column by its editor T.N. Ninan, where he argues:
“For years, the wunderkinds of the financial world have railed at the Reserve Bank’s dullness and stupidity, its unwillingness to allow innovations, and its excessive caution. But the RBI seems about to have the last laugh. Those super-bright financial brains who created those wondrous hedging options, innovated away with structured products till no one knew or understood what was going on, and who thereby created massive value for their firms (the profits of financial firms in the US have grown to account for 41 per cent of all US corporate profits!) while earning fat bonuses for themselves, have to explain why they and their firms have to be saved by the American taxpayer. The US fiscal giveaway is already $150 billion, and the Fed has shelled out more and more money to keep the financial wheels greased while crashing interest rates despite the risk of inflation — all this to salvage the wreckage created by Manhattan’s ‘masters of the universe’.
So why is India safe amidst this turmoil? Because the Reserve Bank has done the things that people laughed at. It issued market stabilization bonds and absorbed dollars; now if overseas investors suck out dollars after selling shares, there is no shortage of dollars to sell to them; and, there will be no domestic liquidity crisis because the RBI can buy back those bonds and pump rupees into the market. Further, the RBI has made banks keep 7.5 per cent of their deposits in cash, and another 25 per cent of their deposits in government bonds. So even if there were to be a run on a bank — as with Northern Rock and Bear Stearns—they would have the liquidity to tackle the situation, so long as they are solvent; and bank solvency has improved because of financial reforms over the past 15 years.
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This is therefore playing out as a repeat of 1997 — India was seen then as being free from the East Asian virus because it had not fully integrated with the region, on trade or capital flows. Now, the lack of sophistication in the Indian financial market is providing protection in a world marked by financial contagion. Hastening slowly when it comes to financial innovation seems to be a wise rule.”
This indicates the benefits of an economy maintaining some level of controls, without fully integrating into the global economy. I am also reminded of arguments of the same nature made by Joseph Stiglitz (a Nobel-prize winner for economics) in his book “Globalization and its Discontents”. Specifically, in the context of the East Asian Crisis of 1997, he demonstrates that countries like Malaysia that were quick to impose capital controls suffered less than others like Thailand and Indonesia that did not impose such controls.
On a more specific aspect of the Indian economy, i.e. the idea of establishing an Indian sovereign wealth fund (SWF), Swaminathan S. Anklesaria Iyer considers an interesting dynamic in a Times of India column. While the establishment of a sovereign wealth fund by the Indian Government will augur well in the longer term (a matter that we have argued too earlier on this blog – here and here), the incumbent Government may have scored a political victory by avoiding the establishment of an SWF that could potentially have lost value of its investments in the current market crisis. Iyer says:
“Sonia Gandhi should thank Finance Minister Chidambaram for resisting proposals to put part of India’s foreign exchange reserves into a Sovereign Wealth Fund, which would buy equity shares in top global companies. Such a Sovereign Wealth Fund (SWF)—an idea backed by eminent economists, the Prime Minister and the Planning Commission—would have suffered huge losses because of the collapse of global stock markets since January. Neither Opposition politicians nor the public would have been satisfied by explanations that stock markets yield high long-term gains, notwithstanding short-term fluctuations. The Left Front would have accused Chidambaram of gambling away the country’s precious assets in casino capitalism. Others would have accused top Congress politicians of having been bribed or arm-twisted into making dubious investments.
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However, Chidambaram and RBI Governor Y V Reddy opposed any SWF for India. Reddy said SWFs were appropriate for countries with mineral windfalls (such as oil exporters), but not India. Indeed, India ran a modest current account deficit, and so needed to import dollars. Now, the world had flooded India with far more dollars than it could absorb, but this was not a structural surplus. Chidambaram took refuge in a further technical argument. He said that SWFs made sense for countries with excess savings, reflected in a fiscal surplus. But India ran a large fiscal deficit. However, these technical economic arguments pale besides the political ones. The stock market is seen by both Opposition politicians and the general public as a dodgy place full of crooked manipulators (remember Harshad Mehta and Ketan Parekh). Making money on the stock market is seen as risky, if not actually sinful. Indeed, the Left front has stymied attempts to put pension/provident fund money into Indian equities. In these circumstances, Chidambaram has shown sound political judgement in refusing to set up an SWF. This might in the long run yield some financial gains. But it carries short-term risks, as has just been demonstrated by the slump in stock markets. So, it needs to be avoided in the run-up to the next general election.”
While these political arguments may support short-term policies, they may overshadow the longer-term benefits of creating an Indian SWF.